* Macroeconomics > the sum of its parts Macroeconomics - Big picture, overall behavior of the economy. VS Microeconomics - Individuals (firms) decisions and their consequences. Paradox of Thrift: When business / families are worried about an economic downturn, they cut spending.This reaction depresses the economy because consumers are spending and businesses react by laying people off. Keynesian Economics - economic slumps are caused by inadequate spending, and they can be mitigated by government intervention. Monetary Policy - uses changes in the quantity of money to alter interest rates and affect overall spending. Fiscal Policy - uses changes in government spending and taxes to affect overall spending. Recessions - or contractions, are periods of economic downturn when output and employment are falling. Expansions - or recoveries, are periods of economic upturn when output and employment are rising. Business Cycle - short-run alternation between recessions and expansions. (Business Cycle) Peak - the highest point of an expansion before a recession begins.2 (Business Cycle) Trough - the lowest point of a recession before an expansion begins. Long-run economic growth - sustained upward trend in the economy's output over time. (Long-run economic growth) Per-capita is key to higher wages and a higher living standard. The rising overall level of prices is Inflation. The falling overall level of prices is Deflation. Open Economy - an economy that trades goods and services with other countries. Trade Deficit - a country runs a Trade Deficit when the value of goods & services bought from foreigners is more than the value of goods and services it sells to them. Trade Surplus - a country runs a Trade Surplus when the value of goods & services bought from foreigners is less than the value of the goods & services it sells to them.3 GDP and the CPI: Tracking the Macroeconomy What is GDP? Gross Domestic Product → The total value of all final goods and services produced in the economy during a given year.
The total value of all final goods and services produced in the economy during a given year, calculated using the prices of a selected base year.
The value of all final goods and services produced in the economy during a given year, calculated using the prices current in the year in which the outpost is produced.
● Economic activity is best measured by real G DP because, in order to accurately measure an economy’s growth, we need a measure of aggregate output. Otherwise a perceived increase in GDP could be due simply to inflation (an increase in aggregate price levels). Aggregate output → The economy’s total quantity of output of final goods and services. Final Goods→ (consumer goods), Goods that are ultimately consumed rather than used in the production of another good. HOW IS GDP MEASURED?: ● Three methods of measuring GDP ● Two main methods are value-added and expenditure approaches Value-added approach: ➔ Measuring GDP as the value of production of final goods and services. ➔ Add up the value of the final goods and services produced in the economy. ➔ Do not count intermediate goods because this would cause the counting of the same items several times and artificially inflate the calculation of GDP. ➔ To avoid double counting, we only count each producer's value-added in the calculation of GDP. Value-added = The value of sales - cost of intermediate goods4 Expenditure approach: ➔ Spending on domestically produced final goods and services, adding up aggregate spending on domestically produced goods and services (flow of funds into firms). ➔ Count only the value of sales to final buyers, such as consumers, firms that purchase investment goods, the government, or foreign buyers (aka, omit sales of inputs from one business to another). ➔ Final sales include factors of production, NOT INPUTS. C = consumer spending I = investment spending, sales of investment goods to other businesses G = government spending on goods and services X = sales to foreigners, exports IM = spending on imports GDP = C + I + G+ (X - IM) Income approach: ➔ Factor income earned from firms in the economy. ➔ Add up all the income earned by factors of production from firms in the economy, such as: ◆ Wages earned by labor ◆ Interest paid to those who lend their savings to firms and the government ◆ Rent earned by those who lease their land or structures to firms ◆ Dividends, the profits paid to the shareholders, the owners of the firm’s physical capital ➔ NOT AS MUCH EMPHASIS ON THIS METHOD Price Index (PI) → Measures the cost of purchasing a given market basket in a given year, where that cost in normalized so that it is equal to 100 in the selected base year. Market basket → A hypothetical set of consumer purchases of goods and services. Consumer Price Index (CPI) → Measures the cost of the market basket of a typical urban American family. Inflation rate → the % change per year in a price index → typically CPI. PI in a given year = cost of market basket in a given year / cost of market basket in base year Inflation Rate = (PI in year 2 - PI in year 1 / PI in year 1) * 1005 Base year → The year used for comparison in the measurement of business activity or economic index, (aka first year). Disposable income = Income + (Government transfers - taxes) → total amount of household income available to spend on consumption and to save. Investment spending → Spending on productive physical capital such as machinery and construction of buildings, and on changes to inventories. Important equations: Real Interest rate = Nominal Interest rate - Inflation rate Nominal Interest rate = Real Interest rate + Inflation rate Inflation rate = Nominal Interest rate - Real Interest rate6 Unemployment and Inflation Labor Force = Employment (full/part time) + Unemployment (looking, but not employed) Unemployment Rate → The % of the total number of people in the labor force who are unemployed. Unemployment Rate (UR) = (Unemployed/ Labor force) * 100 - UR is a good indicator, generally, of how easy it is to find a job given the current state of the economy. - Not a literal measurement of the % of people who want a job but can’t find one, because it’s not 100% accurate at depicting the true state of job availability. - Can overstate and understate true level of unemployment. - Never hits 0% even when there are plenty of jobs available, because there are always people looking. - Not everyone wanting a job, who isn’t employed, is counted as unemployed. Labor-force Participation Rate → The percentage of the population aged 16+ that are in the labor force. *The following three are types of workers are not counted in UR: Discouraged Workers → Non-working people who are capable of working but are not currently looking for work. Marginally Attached Workers → Would like to be employed and have looked for a job in the recent past but are not currently looking for work. Underemployment → The number of people who work part-time because they cannot find full-time positions. *U-6 takes all factors into account all factors, including all the ones above, and is substantially higher than the rate quoted by news outlets.7 Jobless Recovery → (“growth recession”),Period in which the real GDP growth rate is positive but unemployment rate is still rising. Frictional Unemployment → Unemployment due to the time workers spend looking for a job. - Not always a bad thing especially when UR is lower, better when workers spend time to find a job that suits their skills. - Frictional unemployment exists even when the number of people seeking jobs is equal to the number of jobs being offered → i.e. existence of frictional employment does not mean that there is a surplus of labor. Structural Unemployment → More people are seeking jobs in a particular labor market than there are jobs available at the current wage rate, even when the economy is at the peak of the business cycle. - Structural unemployment occurs when the wage rate is, for some reason, persistently above equilibrium wage rate. *Minimum wage → Government-mandated price floor of wage rate. Efficiency Wages → Employers pay their workers above market equilibrium, in hopes that they’ll attract more productive workers, reduce turnover, etc. Natural rate of Unemployment → The UR that arises from the effects of fictional plus structural unemployment. Cyclical Unemployment → The deviation of actual rate of unemployment from the natural rate due to downturns in the business cycle. Inflation & Deflation - Policies that aim to lower unemployment often raise inflation. - Policies that aim to lower inflation often raise unemployment. * Inflation rises → Borrowers benefit, Lenders suffer * Inflation falls → Lenders benefit, Borrowers suffer (harder to decrease than to increase)8 Disinflation → Bringing inflation rate down. Real Wage = wage rate / price level Real Income = income / price level Shoe-leather costs → The increased costs of transactions caused by inflation. Menu-cost → The real cost of changing a listed price. Unit-of-account costs → Arise from the way inflation makes money a less reliable unit of measurement. Interest Rate (on a loan) → The price, calculated as → the % of the amount borrowed, that lenders charge borrowers the use of their savings for one year. - Nominal → In dollar terms - Real → Minus Inflation9 Long-run Economic Growth Sources of Economic Growth: 1.) Increase in technology a.) Makes labor more productive b.) Productivity → productivity of labor → GDP / Labor (L) 2.) Trade 3.) Increase in GDP per capita Rule of Seventy = 70 / Annual Growth Rate → approx. time it will take for GDP to double ● Overall GDP per capita shows Economic Growth Aggregate Production Function → Y/L = f ( K/L, H/L, T) K/L → Physical capital H/L → Human capital T → Technology %GDP/capita = % K/L + % H/L + % T ● Solow Residual = Technological Progress Factors of Economic Growth: - Education - Investment Spending - Research & Development10 Education → Growth and Growth → Education = Reverse Causality Economic theory saying → Education =/= Growth but, Institutions → Growth and, via institutions, Education → Growth If Institution → Education → Growth Poverty Poverty Trap: - Assistance from an outside source is necessary to get out of the trap / cycle until a country / person or family can support themselves Estimating the Gini Coefficient:11 Savings, Investment Spending, and the Financial System Savings-Investment Spending Identity → Savings and Investment spending are always equal for the economy as a whole. Savings & Investment Spending
- No exports (X = 0) - No imports (IM = 0) - Overall (total) Income = Total Spending - GDP = C + I + G - GDP = C + G + S(aving) - Consumption spending = (C + G) - C + G + S = C + G + I = GDP - S = I or Savings = Investment Spending
- Goods & Money can flow in and out of the country - Inflows - Outflows - Not all savings are from domestic sources
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Budget Surplus → The difference between tax revenue and government spending when tax revenue exceeds government spending. Tax Revenue (T) - Gov. Spending (GS) = Positive Budget Deficit → The difference between tax revenue and government spending, when government spending exceeds tax revenue. Tax Revenue (T) - Gov. Spending (GS) = Negative Budget Balance → The difference between T and GS. ● Government Savings (S gov. = T - G - Government Transfers [TR] )12 National Savings → The sum of private savings and the budget balance, is the total amount of savings generated within the economy. ● National Savings = Investment or S national = I Loanable Funds Market → A hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders. ● In a closed economy → Savings = National Savings ● In an open economy → Savings = National Savings + Capital Inflow - Lenders + Borrowers matched up in a way that is similar to Producers + Consumers, via market that is governed by Supply & Demand - Price that is determined is the interest rate, denoted as r → the nominal interest (does not account for inflation) - Many different types of loans Demand for Loanable Funds Determinants: - Higher interest rate means, higher opportunity cost of investment, means lower quantity of demand of loanable funds. -
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